My Fearless Forex Forecasts for 2010

As much as I would love to be your knight in pipping armor and say that everything will be bright and rosy for the labor market come 2010, I simply just can’t.

The BLS or the Bureau of Lying Statistics… errr, I mean the Bureau of Labor Statistics, has reported that the unemployment rate is now at 10.0% in the US, which is an improvement from its peak of 10.2% in October. As I’ve said before, on a month-on-month basis, this would appear to be fine and dandy. However, let’s not forget that more than 7.16 MILLION workers have already lost their jobs in less than two years! The underemployment rate, which adds those who previously looked for work but have stopped and those who work part-time, stands at a whopping 17.2%!

In addition, if we take the birth-to-death ratio of job creation in consideration, the labor situation looks even uglier. For instance, in order for the US labor market to return to its former glory and keep up with the growing workforce, it must create 20 million jobs by the end of 2010. That’s a small country right there! And I’m betting the same could be said for the other G7 nations.

Too much gloom and doom for ya? Wait, there’s more!

You see, the problem with the labor market is that it is one of the last to show signs of recovery. In the past recessions, it took at least two years after the US posted GDP growth before companies began hiring consistently again. With the US economy only expanding during the third quarter of 2009, we may only see the labor market grow mid-2011 at the earliest.

Interest Rates Projection

On a brighter note, there are plenty of good things to look forward to in 2010… The Winter Olympics in Vancouver, a new judge on American Idol (hint: Ellen!), Ironman 2, and possibly the Lakers repeating as NBA champions, just to name a few. Oh, and one more thing: More interest rate hikes, perhaps?

Well, the prospect of an interest rate hike depends largely on the economy’s inflation figure. Inflation is not necessarily bad, as long as income grows at a faster, or at least equal, pace as the increase in general prices. In fact, this is the reason is why central banks from all over set inflation targets ranging from 1.5% to 3%. What then merits a rate hike? Since interest rates and inflation tend to be negatively related, an inflation figure below the central bank’s target would require a lower interest rate in order to stimulate consumption. Eventually, this would lead to a rise in inflation.

As of November 2008, the US’s annualized core inflation rate stood at 1.7%. Given this, the Fed is likely to keep interest rates at current levels until inflation goes over the bank’s core target range of 1.8% to 2%. In the UK, consumer prices have increased by 1.9% during the same period and are seen to rise to 3%, which is just around the BOE’s upper band target, sometime next year. Similarly, euro zone’s year-over-year CPI unexpectedly rose by 0.1% in November. However, this is still below the ECB‘s 2% target.
In order for inflation to pick up, local consumption and effectively the country’s gross domestic product need to pick up. Until both inflation and GDP rise, we may expect central banks to keep their benchmark rates at current levels.

Japan’s situation is a different story altogether. Remember that it was able to finally escape recession after posting 2.3% growth during the second quarter of 2009. Despite this, the Samurai warriors down at the BOJ are most likely to maintain its interest rate at an all time low of 0.10%. In fact, they may even boost further its quantitative easing measures.

Why?

Well, deflation happens to be plaguing the Land of the Rising Debt, I mean Sun, with a dismal annualized CPI of -2.5%. If you’re wondering how the country managed to post positive growths during the previous quarters, the answer lies, not in the country’s domestic consumption, but in the government’s massive spending!

The Backlash of Debt

Speaking of over-spending, the first half of the upcoming year could be filled with more news of credit concerns as excessive (and nearly unmanageable) amounts of government spending eventually take their toll on several economies. Debt concerns that plagued the latter part of 2009 served as a painful lesson that massive stimulus spending to boost the economy comes at a price… and those not prepared to manage the costs get slapped on the wrist with a debt rating downgrade while some are lucky enough to get off with just a warning.

Topping the debt threat watch list is Japan, whose debt is projected to swell to almost TWICE as much of its $5 trillion economy in 2010. That means its debt is seen to approach a massive $10 trillion by next year! Since this restrains further policy spending, the BOJ may be forced to increase its purchases of government bonds, resulting to more monetary policy easing. As Japanese policymakers scratch their heads in figuring out how to make ends meet, the Asian giant faces a pending debt downgrade from Fitch if it exceeds its Â¥44 trillion limit on bond purchases in 2010. Uh-oh… I’d keep an eye out for that.

Next on the list is the UK, which is on the verge of getting a sovereign debt downgrade with its whopping Â£175 billion budget deficit. With the UK as the only major economy still stuck in the recession rut, the British government is feeling pressured to pump up their stimulus programs and consequently increase their spending. Note that as of November 2009, UK’s net public sector debt amounts to a scary UK public Â£829.7 billion ($1.382 trillion – that’s with a capital T!).

However, the BOE seems to have exhausted its limit on bond purchases so the British government might have to look elsewhere for funding. And if UK finally gets the credit rating downgrade it deserves, who would want to buy their government bonds and provide sovereign funds? My oh my, it looks like the pound may be headed down to bloody hell for 2010 if the situation doesn’t turn around soon.

Back to the Fundies?

For the most part of 2009, risk sentiment has been driving the market. It basically went like this: whenever good data came out, it helped boost risk appetite, which led to rallies in higher yielding currencies (shout out to the Aussie and Kiwi!). The opposite happened if bad news came out; traders and investors would buy up dollars. Yet, a run of good economic data seemed to push traders to shift gears, as 2009 ended with a stunning dollar rally.

The question is: Are we seeing a shift in the sentiment versus fundamentals paradigm or is there something else at play here? In my humble opinion, I think we could be seeing a mix of both. As I said above, the Japan and UK situations aren’t exactly looking like a Thanksgiving turkey right now. With growing debt concerns, this may be sparking a run of risk aversion.

At the same time, let’s not forget that the US economy has been showing some signs improvement. Rising retail sales, smaller job losses, and the possibility of a rate hike coming sooner than expected… sounds good, eh?

Seeing that the US government was one of the first to act, more so doing it in grand fashion, they may also be one of the first economies, aside from Australia, to see a quick and stable recovery. In the end, the prospect of a relatively better economic situation may drive the dollar back on top of the currency markets.

2010 Forex Awards

Let me go out on a limb here and say that my nominees for “Best Performing Currency of 2010” are the greenback, Aussie, and the Kiwi while my top contenders for the “Worst Performing Currency of 2010” are the pound, euro, and yen. And the award goes to…

Well, I can’t tell you that yet – I’m no fortune teller! Better stay tuned to my blog to find out. I hope you enjoyed my fearless Forex forecasts for 2010. Peace out y’all and have a Happy and Prosperous New Year!

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